Types of Mortgages and their Pros and Cons

The Doc Explains: Mortgages and their Pros & Cons

There are basically two main types of residential mortgages and a number of other mortgage products designed for specific needs. Below is a list of the more common types of mortgages, along with some of their Pros and cons.

1. Fixed-rate mortgage (FRM)

    Pros:
      - The interest rate and monthly payments remains unchanged over the term of the mortgage.
      - Easier to understand and budget for.

    Cons:
      - Borrower cannot take advantage of falling interest rates.
      - Lenders are not usually flexible with the terms and conditions.
      - Rates are somewhat higher than other types of mortgages.

2. Adjustable-rate (ARM)

    Pros:
      - The rate is usually lower than that of a fixed-rate mortgage. 
      - Compared to an FRM, the chances of getting a larger mortgage are better.
      - Falling interest rates work to the advantage of the borrower, reducing monthly payments.
      - Lenders will show more flexibility in meeting a borrowers requirements.

    Cons:
      - After an initial period, any rise in interest rates will increase monthly payments.
      - More difficult to understand.
      - Less knowledgeable borrowers may be vulnerable to shady mortgage practices.

3. Federal Housing Administration (FHA) Loan

    Pros:
      - Generally, it carries a lower interest rate than conventional loans.
      - Relatively easy to qualify for.
      - The loan is guaranteed by the Federal Government.

    Cons:
      - Requires a good and stable employment track record.
      - A down payment of less than 20% may require the payment of mortgage insurance.
      - A property has to meet minimum standards of habitation.

4. Veteran Administration (VA) Loan

    Pros:
      - Guaranteed loans for active duty personnel, eligible veterans and their surviving spouses.
      - Competitive Interest rates.
      - Low or zero down payments.
      - Easy to qualify for.
      - Easier to refinance a VA Loan than a conventional loan.

    Cons:
      - Limits on the size of loan.
      - A down payment of less than 20% requires the payment of mortgage insurance.
      - To guarantee the loan, a Funding Fee is charged. Typically it is 2% for new loans or 0.5% on refinance loan).

5. Balloon mortgage

    Pros:
      - This is a fixed rate home loan for a period of five to seven years. Monthly payments are not subject to interest rate fluctuations.
      - Most balloon mortgages provide an option to convert to a new loan after the initial term.
      - Relatively easy to qualify for.

    Cons:
      - Higher risk of foreclosure, as the entire balance of the loan has to be paid back when due.

5. Interest-Only mortgage

    Pros:
      - Low monthly interest only payments, on a fixed term mortgage.
    Cons:
      - Risky for a borrower as the full balance of the loan is due at the end of the term.

For more detailed information on mortgages go to Bocazo's Mortgage Library